State of the Union (2012)

Presented by Malcolm Robinson

The State of the Union is a political speech so it shouldn’t be surprising that, listening with my economist’s ears, I was mildly disappointed. The speech was full of small ball populist proposals that play well across the country – the pollsters dial showed lots of positive activity that evening. The President’s big theme, create an economy “built to last” is certainly unobjectionable.

I was pleased that the President turned away from his wrong headed emphasis on deficit reduction from last year; I was disappointed that the President failed to emphasize his fiscal end health policy successes. I was displeased – for the third year in a row! – that he didn’t offer more urgent words and proposals on our most pressing present problem – mass unemployment. The fact that 5.5 million Americans are unemployed for longer than 26 weeks is a symptom of our nation’s deep economic problems. It is hard to believe but the U.S. labor market started 2012 with fewer jobs than it had in 2001! Even as the population has grown! The civilian employment to population ratio bottomed out in 2009 and has pretty much not budged since (Figure 1). The average duration of unemployment has risen from about 17 weeks in 2007 to about 40 weeks today (Figure 2).

The President often uses the rhetorical formula in this speech that “the State of our Union is strong”. President Obama said something which I’d like to elaborate upon today. He said “the State of the Union is getting stronger”. I believe that this is true. I said here 4 years ago that I hope to be optimistic again and I feel I finally have good news to report.

I have a friend – let’s call him “Bob” – who was stunned when I told him that I was optimistic. Hasn’t the unemployment rate been above 8% for 3 years now?

The facts are (Figure 3) the recession is over and the drop in U.S. production during the recession was steep. On a year to year basis, production fell from 2008 to 2009 by about 5% (the U.S. usually adds about 3% more output every year if you look from 1970-2007); the decline was twice as steep as originally estimated. The recession ended in mid 2009 and the U.S. now produces more output today than we did when the recession started – although it took us 3 ½ years to achieve this outcome. This recession fits in pretty well with the stylized facts emphasized in Reinhart and Rogoff’s, This Time It’s Different (2009) (Figure 4). Recessions accompanied by financial crises tend to be deeper and harsher than usual and the median recovery time for their sample was fairly long, about 5 years to return to full employment. Ireland, for example, has yet to catch up to its peak production (Figure 5a and 5b). England has yet to recover too; it recovered faster after The Great Depression.

Why do so many people believe we’re still in a recession? We’re producing a lot less today than we could be if we had simply stayed on our usual path of GDP growing by about 3% a year (Figure 6). Imagine a path fitted through the data pre 2008 and then a path fitted through the data post 2009. Those two paths won’t intersect until 2022 if the U.S. adds about 200,000 jobs per month, until about 2019 if the U.S. adds 250,000 jobs per month (Figure 7). The economy has failed to “snap back” like it once did (Figure 8). Look at the recessions prior to 1991, the rate of growth turns negative and then sharply rebounds. Our recession is like the 1991 and 2001 recessions – we haven’t even recovered our “normal” 3% annual growth.

Part of this is due to the housing market. Housing starts are still at historically low rates (Figure 9). But the automobile industry is finally recovering (Figure 10) and the unemployment rate is at 8.3% down from its peak at 10.1% (Figure 11). In the past, I have discounted declines in the unemployment rate as an illusion because the unemployment rate falls as the labor force shrinks (Figure 12) but the labor force began trending up in the middle of 2011 and rose more in the beginning of 2012. This decline in the unemployment rate is real and is fueled by fewer and fewer Americans losing their jobs each week.

It’s important to understand that the U.S. economy is a job creating and job destroying machine. Every week, companies go out of business; every week, new companies start up. We can get a sense of how many Americans are losing their jobs by looking at first time unemployment claims (Figure 13). If you look at either frame, you can see the number of first time jobless claims start to rise in 2007 as the recession begins and peaks in 2009 as the recession ends. The economy improves through 2010 and then gets stuck and then improves into 2011 and then got stuck at an unhealthy 400,000 claims a week. It’s hard to bring the unemployment rate down with that rate of job separation. But first time claims are again trending down – to about 350,000 for the last 2 weeks. You can see that the economy was not healthy in 2003 and then it boomed through 2007. A truly healthy economy will report about 315,000 new claims. You’ll know if the economy is getting healthier faster than it is now if first time claims fall to 320,000 or lower per week. If you were to look back at average unemployment duration, you’ll see it shrunk from 2003 to 2007 as the unemployment rate declined from about 6 to 4.5% (Figure 14).

The U.S. economy, however, is simply creating too few jobs – we have a problem of too little demand for labor. The ratio of job seekers looking for work to the number of job openings is finally below 4 (Figure 15), but this still means there are no available jobs for 3 out of 4 job seekers. This is certainly better than no jobs for 6 out of 7 job seekers but this is a far cry from the economy George W. Bush inherited when the unemployment rate was 4% and the job seeker ratio was 1.1. The Bureau of Labor statistics tells us that 260,000 payroll jobs were created in December of 2011 and 243,000 were created in January of 2012 – significantly more than the 100,000 to 120,000 jobs needed to keep unemployment rate constant. However, the government – state, local and Federal – is doing too little to help; the shrinking of the government sector as the stimulus has petered out has actually served as a drag on economic growth as the states and localities continue to pull back (Figure 16 and 17).

The last few years have confirmed that the world is really best explained through a Keynesian lens.

The President’s budget, therefore, does a lot of things correctly – it pushes substantial budget deficit reduction off into the future when the economy should be healthier and it provides for short term temporary stimulus today. The President called for a payroll tax cut (100 billion) and extended unemployment insurance for a year. The $30 billion to modernize 35,000 schools, the $30 billion to rehire teachers, police, and firemen, the $50 billion this year for transportation infrastructure spending help to fill in the decline in government spending and slow the bleeding of state and local jobs. Won’t this increase the deficit? Haven’t our large deficits driven up interest rates and discouraged private capital formation? Well, no. Interest rates on 10 year treasuries are historically low (Figure 18). Ten year treasuries are at around 2%. This means financial markets expect interest rates to average about 2% for the next decade. This means that financial markets forecast that government borrowing won’t crowd out private sector spending and investment and, hence, retard growth. The component of investment that has yet to recover is the housing component; business investment in equipment and software has more than recovered to its pre-recession level (Figure 19).

I suspect that the reason we are not acting more boldly on the economic front is that political constraints are binding upon policy makers. It may have been economically possible to speed up our recovery – our time could have been different, we could have ended up in the low range of the Reinhart and Rogoff data set – but the political environment before the crisis and the political environment after the crisis (due to the debt brought on by trying to ameliorate the crisis) became markedly different and our economic hands became tied.

Still, the President has repeatedly failed to make the case that it is morally indefensible to allow cyclical unemployment to morph into structural unemployment. We shall all be poorer because of that. Mind you, it could have been much worse if we had heeded the call for immediate austerity and deficit reduction – this is the lesson from 1937 in the U.S. and the lesson from the EU today. It’s just that things could have been so much better.